Is There Movement in the Industrial Real Estate Markets?

With a weak dollar boosting global demand for U.S. exports and the domestic economy inching back from the brink, industrial activity is starting to bounce back. Consequentially, so is the health of most U.S. industrial real estate markets.

As is typically the case after a tough recession craters demand for space, market fundamentals and transaction velocity are rebounding in erratic fashion around the country. The same holds true for effective rental rates, which have been picking up sharply in high-demand markets such as the San Francisco Peninsula and some D.C. suburbs, but still falling in tougher locales including Baltimore, Maryland, and Long Island, New York, Cushman & Wakefield (C&W) reports.

If vacancy rates are any indication, it’s pretty clear that more markets are making progress than backtracking. Indeed, during this year’s first quarter, 37 of the 60 industrial markets CB Richard Ellis’s Econometric Advisors (CBRE-EA) research group tracks saw vacancies fall, while 20 saw availabilities increase (three of the industrial markets held firm).

Hence, with property sales and leasing activity clearly rebounding in the nation as whole—and with speculative development nearly nonexistent—the near-term prognosis for market health is generally positive.

But, again, the budding recovery seems slated for anything but a smooth ride. Trade-reliant markets appear best positioned, with manufacturing centers close behind, followed by more distribution-oriented local economies, predicts Diego Iribarren, senior economist with CBRE-EA.

“In the short term, markets driven by international trade will benefit from the dollar’s current [temporary] weakness,” Iribarren elaborates, citing export-heavy areas such as Los Angeles, Miami, Baltimore, and Houston.

“Major manufacturing markets” including Detroit, Orange County, and Chicago should likewise recover with better-than-average gusto, Iribarren continues. “These markets will benefit from an expansion in foreign demand for U.S. products as well as domestic demand.”

What to do?

Tenants looking to lease industrial facilities may want to act sooner rather than later. While rents remain near cyclical troughs in many markets—and aren’t likely to post lightning-quick rebounds—it’s pretty clear the general movement will be upward for the coming couple years.

McArtor expects effective rental rates for large available industrial properties to move upward throughout the year, with rents for spaces measuring 400,000 square feet (37,200 sq m) or more increasing “dramatically” in many markets.

With rents starting to turn positive in healthier markets, savvy landlords with vacancies to fill ought to start focusing more on longer-term revenue streams, rather than discounting heavily in the near term to attract new tenants at any cost, advises veteran owner/operator Phil Hawkins, CEO of public real estate investment trust (REIT) DCT Industrial Trust.

Investors such as DCT with access to capital can still secure decent immediate returns on industrial acquisitions, even though values have already rebounded sharply. Pricing appears poised for further appreciation—and there seems to be room for more capitalization rate erosion absent a dramatic interest rate spike.

First-year cash yields on DCT’s late-2010 acquisitions of distribution properties averaged 7.9 percent, Hawkins recently told conference callers. The REIT has targeted somewhat more speculative investments so far this year, trading off somewhat lower going-in returns to acquire properties that should generate yields in the mid-8s as improvement and leasing programs are completed.

As of the end of March, average industrial property values nationwide were up 23 percent over 12 months and 33 percent since the April 2009 cyclical trough—but still 18 percent below the previous peak in November 2007, according to the Commercial Property Price Index from Green Street Advisors.

As for wannabe developers: rents will have to recover quite a bit more before anything but special-use properties start penciling out again. Most of the limited industrial construction underway today represents highly “specialized” facility requirements, Hawkins adds.

To wit, C&W calculates that industrial building completions across the country last year amounted to hardly 15 million feet (1.4 million sq m)—the lowest level the brokerage has ever recorded.

While C&W also reports that 2010’s fourth quarter was the first three-month period to see positive net absorption of industrial space nationwide since mid-2008, landlords still face considerable challenges in many markets. Perhaps foremost, the national vacancy rate remains stubbornly in double-digit territory at 10.2 percent, according to C&W.

And rents are still well off the 2007 cyclical peak, which researcher Reis Inc. pegs at $4.70 per square foot ($50.53 per sq m) annually. Reis is projecting that the average effective rental rate nationwide will increase by a modest 0.7 percent over the course of 2011, to $4.21 per foot ($45.27 per sq m).

Likewise, many owners and lenders will continue struggling with financial distress. The delinquency rate for securitized industrial-property mortgages hit double-digits for the first time in January, according to Trepp LLC.

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